Mid & small-caps witnessed earnings expansion almost twice that of earnings of Sensex Firms...! By Vinay Khattar, EdelweissWith every bull market run, investors start scouting the next multibaggers. These multibaggers are more often found not only in beaten down sectors and stocks but more so amongst the smaller companies listed on the exchanges. A peep into the history tells us that in the last bull cycle 2003-2008, market value of Sensex increased by 6x, but BSE 500, a more broad based index, grew by almost 9x. This was not just because of valuation rerating happening in the markets, but also because earnings growth of smaller companies was playing out more vigorously. Mid and small-cap companies witnessed earnings expansion almost twice that of earnings of Sensex companies. A combination of earnings growth and expansion in valuation becomes a strong inducement for smart investors to focus on mid and small-caps during bull markets.There is another interesting aspect of why mid-caps enthuse smart money. Warren Buffet puts it beautifully: “You can’t win by being where the ball is, but where it is going to be.” Hence, the possibility that large caps of today become mega caps tomorrow is much lower than small caps of today becoming large caps of tomorrow. To buttress the point, let’s look at the historical composition of S&P 500. The average lifespan of a company in the S&P 500 has decreased from 90 years in 1935 to 18 years today. At the current churn rate, 75% of S&P 500 index by 2027. Coming closer home, 21 out of 30 companies have been replaced in Sensex in last 10 years. So, the place to look for next multibagger is not large-cap indexes but amongst the smaller companies.Historically, it has also been observed that small and mid-caps are bigger wealth creators. To put things in perspective, in 2003, the market capitalisation of Sensex was Rs. 6 lakh crore while that of Maruti Suzuki (MSIL) was Rs. 11,000 crore and that of Motherson Sumi’s was Rs. 1,083 crore. As of today, Sensex’s market capitalisation is Rs. 57 lakh crore (9x growth). MSIL’s market capitalisation stands at Rs.2.3 lakh crore (20x growth) while Motherson Sumi’s market cap has gone up to Rs. 78,000 crore (78x growth). So, the ability of a good small-cap to generate wealth is far greater than that of even a well-performing large-cap.More interesting insights come to fore when we look at relatively lesser discovered stocks and sectors in the market. Let’s take a peep into the milk industry in India. India and Europe produce close to 150 million tonne and 160 million tonne of milk every year with 18% and 20% global market share, respectively. But the size of the dairy industry in India is Rs.6 lakh crore whereas that of Europe is Rs.21 lakh crore, 3.5 x India’s size. This is mainly because large quantity of milk in Europe gets processed into higher value products like cheese, butter, chocolates etc, a path on which Indian milk industry is beginning to venture on.More interestingly, the total market capitalisation of all listed companies in India in this space is just Rs. 30,000 crore, while the top two companies in Europe boast of a market value of Rs. 5 lakh crore. As India grows to become a $5 trillion economy, wealth creation opportunities that could be presented by mid and small-caps in sectors such as these could be humongous.